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Pros and Cons for Investing in Target

John Divine

In 2017, Target Corporation (ticker: TGT) announced it would invest $7 billion over three years to "adapt to rapidly evolving guest preferences." As the news release made clear, that was essentially a euphemism for investing in its e-commerce operations to combat Amazon.com ( AMZN) in the digital retail sales and delivery space.

The question this brought to mind for investors was simple: Was this too little, too late? Would Target stock respond?

About two and a half years later, the results are coming in convincingly. And the results are good.

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That said, the Minneapolis-based big-box retailer faces an extremely tough, slug-it-out operating environment, competing directly against the likes of Macy's ( M), Kohl's Corp. ( KSS), Walmart ( WMT) and Best Buy Co. ( BBY), as well as digital sales giant Amazon.

How have Target's efforts panned out, and where is the company headed from here? What can investors expect from TGT stock? Let's take a look.

TGT Stock At a Glance

In 2017, Target announced that it would invest $7 billion in its operations by 2020, and that it would also double the amount of its small-format stores and drive their grocery prices lower to better compete with Kroger Co. ( KR) and Walmart.

As part of that initiative, Target has poured $1 billion into its digital retail platform, including faster (and free) delivery options. Wage hikes stemming from late 2017's tax reform bill added to TGT's spending spree.

Target also fired a salvo aimed directly at Amazon -- a free, guaranteed delivery deal for purchases over $35 and for consumers who own a Target REDcard. The delivery service came with a twist: instead of relying on an Amazon-like network of high-functioning fulfillment centers, TGT would deliver goods straight from its stores -- or, as John Mulligan, chief operating officer at Target called them, "mini-fulfillment centers."

Looking back at its aggressive investment announcement in 2017, shareholders can now see whether it's borne any fruit.

Pros to Buying Target Stock

In 2018, before the results of TGT's bold plan had become manifestly plain, Cindy Frick, senior consumer equity research analyst at USAA, painted 2017 as an investment year for Target and summed up what management was hoping to achieve over time.

"TGT increased investments in price, labor, new exclusive private label brands, digital capabilities and supply chain management," Frick says.

"Target expects fiscal year 2019 to be a year of acceleration and transition. In fiscal year 2018, TGT plans to accelerate digital fulfillment options, supply chain investments, store remodels, small format stores and continued wage increases while maintaining more stable gross margins and SG&A as a percentage of sales rates."

In short, the view that forward-thinking investments would lead to 2019 being a year of "acceleration and transition" proved prescient.

In June 2017, TGT stock was trading around the $50 level. After a blowout quarterly earnings announcement in August 2019, shares advanced beyond the $100 level -- representing more than 100% gains in just over two years.

This appears to be a well-deserved increase in valuation: in the last two years, comparable-store sales -- the holy grail of all brick-and-mortar retail metrics -- advanced about 10%. It's Target's best two-year advance in that category in more than a decade.

Earnings per share (EPS) growth came in above 20%. Those same-day fulfillment services TGT invested in? They proved popular with customers. Margins improved too, and TGT hiked full-year EPS guidance. And perhaps the most revealing statistic was online sales growth, which came in above 34% year-over-year.

"We are really pleased with our second quarter performance, which demonstrates the strength of our strategy and the durable financial model we've built over the last several years," says Brian Cornell, Target chairman and CEO.

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Consider the fact that TGT shares surged 20% in a single day after its blowout Q2 2019 results. That resulted in a share price that instantly went from the $80s to the $100-plus range, skipping the $90s entirely.

It's hard to digest the implication that a company as large and well-followed as Target could have been so mispriced and misunderstood as to deserve an overnight quantum leap in valuation. Are expectations too high?

Moreover, a skeptic might conclude that Target is simply benefiting from a solid economic environment.

Target's most direct analogue, Walmart, also saw its largest two-year comparable-store sales growth in more than 10 years in the second quarter of 2019. And the similarities don't end there.

E-commerce sales grew 37% year-over-year at WMT, aided by "strong growth in online grocery." That's bad news for Target not only because it puts Target's supposedly rapid online sales growth into context, but because Walmart's grocery operations are considered more robust than Target's -- and that's a factor that drives traffic growth.

Finally, while it may be poor form to call the mere continued existence of Amazon a "con" for Target stock, it truly is. Despite all the wonderful news that came in Q2 TGT earnings, revenue growth clocked in at just 3.4%. Amazon meanwhile, buoyed by its cloud computing division AWS and its e-commerce-centric retail model, saw Q2 sales jump 20%.

That's quite a difference.

The Bottom Line for Target Stock

It's tough to discount how well Target has executed on its 2017 plans. They were equal parts bold, necessary and risky at the time, and in a Wall Street environment that prizes short-term thinking and quarter-to-quarter profits over longer-term strategy, it took guts to sacrifice near-term profitability for a grander competitive vision.

No risk, no reward.

One-day fulfillment is working out well, digital sales are thriving, and store remodels have facilitated consistently higher same-store sales over time.

While Walmart and Amazon both loom large, that's nothing new for the regularly overlooked redheaded stepchild of American retail. Yes, Amazon's acquisition of Whole Foods and Walmart's own efficacious online strategy may temper enthusiasm, but at a minimum shareholders should have newfound faith in Target's C-suite. Executives show a growing appreciation for customer satisfaction and long-term vision.

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Sure, investors can harbor legitimate concerns about TGT stock rising by too much too quickly. But those who believe that investing in quality companies pays off over time should be reassured by Target's recent financials.

A 2.6% dividend can give income investors something to get excited about, and TGT has shown an ability to weather recessions with some elegance, giving conservative blue-chip-types a reason to buy as well.

As things stand now, the pros seem to outweigh the cons. Retail's sleeping giant is steadily awakening.



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